Standards and Budgets: The Close Relationship

Budgets, as you recall from the previous chapter, are simply plans for expected future performance expressed in quantified monetary terms. They are therefore similar to standards that both set performance and cost levels for control purposes. One would then conclude that budgets and standards are similar in principle although they differ in scope. This difference is explained in the following two points:

  • Standards are a unit concept They apply to particular products, individual processes or single operations.
  • Budgets are concerned with totals They lay the cost limits for functions and departments and for the firm as a whole.

What comes out clearly from the above is that standard cots are the “building blocks and cement” used to “build up” a structure referred to as a budget. This is because a budget is the um of the individual output units costs multiplied by the total output units desired, for example,

Budgeted Material Costs = Standard Material Cost x Number of output units.

                                                                   Per Unit of Output desired.

Finally, standard costs and the variances resulting from their analysis form part of the accounting double entry system, from which the final financial statements are prepared. On the other hand, budgets are simply memorandum figures and do not form part of the accounting double entry system.

The Standard Cost Card

This is a card record of the Standard or expected costs In producing a given output. It gives the physical quantities of inputs as well as their monetary values. It also gives the quality required. E.g. Grade A labour.

The process of setting standards results in the establishment of the standard cost for the product. The make-up of the standard cost is recorded on a standard cost card.

Behavioural Aspects of Standards

Standards and budgets rely heavily on the people who have to work to meet them. Because of the detailed nature of standard costing and its involvement with foremen and production workers, communication is crucial. Production workers frequently view performance review with a lot of suspicion, if a cost-conscious, positive attitude is to be developed, then close attention must be granted to the behavioral aspects of the system. In short, variance analysis is often not considered by those being evaluated as a neutral objective and purely technical process. This is because it has subjective and human aspects which in turn affect the employees’ behaviour in the organization: These are discussed under the following headings:

  • Goal congruence
  • Motivation
  • Communication
  • Participation
  • Goal definition
    1. Goal Congruence

An ideal variance analysis and standard costing system should enhance goal congruence between:

  1. The goal of individual departments and the individual employees and
  2. The goals of the organization as a whole.

This would prevent a conflict of goals and the resulting suboptimality.

However, total goal congruence is an ideal which is difficult to achieve completely and in practice, some reasonable level of sub optimality is ‘endured’ in the organization.

Goal congruence is enhanced when the employees to be evaluated using standard costing system are involved in setting the standards and in evaluating their performance. This participative management style is by far preferred to the traditional autocratic system that overemphasized hierarchy and authority.

    1. Participation

It has already been pointed out in the previous paragraph that standard costing systems would be more acceptable if the employees to be evaluated using those standards are involved in setting the standards. Participation promotes common understanding regarding objectives and makes the acceptance of organizational goals by the employees more likely. Variance analysis and the control process is also assisted by participation of the employees in the investigation of solutions to the problems which arise. If people are genuinely involved, they feel more a part of the team and become highly motivated.

    1. Motivation

Variance analysis and standards setting needs to be carried out such that it motivates managers and other employees. It should not create resentment and adverse reactions. To achieve motivational effects, the process must be:

  • Participative
  • One that encourages initiative and responsibility;
  • One that is not seen as a mere pressure device
  • Must be objective and uniformly applied to all
  • Carried out in time.
  • One that gives fair feedback to the employees, pointing out areas of positive and negative performance.
  • Well linked to the penalty- reward system i.e. the positive performance is rewarded while negative performance is punished or corrected to enhance positive performance.
    1. Goal Definition

The desired goals must be clearly defined to individuals, departments and the organization as a whole. This clears confusion and sets a direction for the whole organization. Cleary defined goals, agreed upon by and accepted by the individuals concerned, will encourage goal congruence and increase motivation.

    1. Communication

The process of communication, across and between the layers in the organization, is a critical element of all control systems. Standard costing, as a performance control systems, is not an exception! Frequent, up to date and accurate feedback of information to employees and managers regarding their performance has a motivating effect. It indicates areas in which improvement is needed so as to achieve the desired objectives. Communication also makes employees feel that their contribution in the organization is important.